IAS
37: Provisions, Contingent Liabilities and Contingent Assets

IAS 37,
Provisions, Contingent Liabilities and Contingent Assets, was approved by the IASC Board in
July 1998 and became operative for annual financial statements covering periods
beginning on or after 1 July 1999.

Summary of IAS 37

IAS 37 requires that:

provisions should be recognised
in the balance sheet when, and only when: an enterprise has a present
obligation (legal or constructive) as a result of a past event; it is
probable (i.e. more likely than not) that an outflow of resources
embodying economic benefits will be required to settle the obligation; and
a reliable estimate can be made of the amount of the obligation;

provisions should be measured in the balance sheet at the
best estimate of the expenditure required to settle the present obligation
at the balance sheet date, in other words, the amount that an enterprise
would rationally pay to settle the obligation, or to transfer it to a
third party, at that date. For this purpose, an enterprise should take
risks and uncertainties into account. However, uncertainty does not
justify the creation of excessive provisions or a deliberate overstatement
of liabilities. An enterprise should discount a provision where the effect
of the time value of money is material and should take future events, such
as changes in the law and technological changes, into account where there
is sufficient objective evidence that they will occur;

the amount of a provision should
not be reduced by gains from the expected disposal of assets (even if the
expected disposal is closely linked to the event giving rise to the
provision) nor by expected reimbursements (for example, through insurance
contracts, indemnity clauses or suppliers’ warranties). When it is
virtually certain that reimbursement will be received if the enterprise
settles the obligation, the reimbursement should be recognised
as a separate asset; and

a provision should be used only
for expenditures for which the provision was originally recognised and should be reversed if an outflow of
resources is no longer probable.

IAS 37 sets out three
specific applications of these general requirements:

a provision should not be recognised
for future operating losses;

a provision should be recognised
for an onerous contract - a contract in which the unavoidable costs of
meeting the obligations under the contract exceed the expected economic
benefits; and

a provision for restructuring
costs should be recognised only when an
enterprise has a detailed formal plan for the restructuring and has raised
a valid expectation in those affected that it will carry out the
restructuring by starting to implement that plan or announcing its main
features to those affected by it. For this purpose, a management or board
decision is not enough. A restructuring provision should exclude costs -
such as retraining or relocating continuing staff, marketing or investment
in new systems and distribution networks - that are not necessarily
entailed by the restructuring or that are associated with the enterprise’s
ongoing activities.

IAS 37 prohibits the
recognition of contingent liabilities and contingent assets. An enterprise
should disclose a contingent liability, unless the possibility of an outflow of
resources embodying economic benefits is remote, and disclose a contingent
asset if an inflow of economic benefits is probable.